Six key survey findings:

Transcription

1 Six key survey findings: Gauging attitudes about target-date funds from plan sponsors and consultants Fall 2011 Executive summary. In March and April 2011, Vanguard partnered with Greenwich Associates and Research Now to conduct an online survey of defined contribution (DC) plan sponsors and consultants who serve DC plans.* The survey sought to gauge current plan sponsor and consultant attitudes about target-date funds (TDFs) and how those attitudes may have shifted over the past three years, a period marked by highly volatile capital markets and ongoing scrutiny of TDFs as an investment for retirement investors. Authors John Ameriks, Ph.D. Brad Redding * This report focuses on mid-to-large-size DC plans and summarizes survey responses from plan sponsors and consultants who oversee plans with at least $50 million in DC assets. Connect with Vanguard > institutional.vanguard.com

2 The survey finds: TDF adoption is high and will continue to rise. Sixty-six percent of plan sponsors surveyed offer TDFs. Among those who don t offer TDFs, 58% plan to add the investments over the next two years. Cost and performance are among the top three TDF selection criteria for plan sponsors offering TDFs and consultants. The two groups, however, differ on the priority of these criteria. Overall, attitudes toward TDFs have become more favorable relative to other investment options. When asked to look back over the last three years, both plan sponsors and consultants hold this view. Sponsors regard favorably the investment merits of TDFs and their role in DC plans. TDFs are considered a better single-fund solution, easier for participants to select, and easier to understand during periods of market volatility when compared with a 60/40 static balanced fund. However, some consider TDFs to be riskier and more complicated. Respondents believe that TDFs are appropriate as part of a multifund portfolio or as a single-fund solution. Respondents indicate more favorable views for TDFs as part of a multifund portfolio, edging out the single-fund solution. TDFs are also suitable for participants generally and as the plan s qualified default investment alternative (QDIA). Most prefer a through glide path design and moderate equity allocations at both the target date and landing point. The ranges of appropriate equity allocations at both points are sizable. To ensure the objectivity of the results, this was a blind study. Vanguard was not identified during the course of the survey. 2

3 1. TDF adoption continues to rise TDF adoption among plan sponsors is 66% and increasing. Among plan sponsors who don t offer TDFs in their lineup, 58% intend to add this suite of investments over the next two years. The top two reasons cited for not currently offering TDFs are administrative and investment-oriented in nature: cost and complication of changes to the investment lineup and the absence of good benchmarks. Given differences in TDFs asset allocations including those who share the same target date there has been no consensus on an appropriate and widely accepted investment benchmark for TDFs, though several providers have emerged in recent years. Dow Jones and Standard & Poor s are two proprietary TDF index providers which represent yet another approach to TDF design. Peer-group benchmarks are available from at least two major providers: Lipper Inc. and Morningstar. In addition, Morningstar has a TDF-ranking system that buckets funds into five categories: top, above-average, average, below-average, and bottom. While some of the Morningstar criteria are quantitative, the company also relies on qualitative evaluations. With cost and complexity both significant considerations, plan sponsors may be less likely to add TDFs to a lineup as a single plan event or change. Instead, it may be more sensible to add TDFs to their lineup in combination with another plan event such as a merger/acquisition, recordkeeper change, or a larger-scale investment menu redesign. Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in target-date funds is not guaranteed at any time, including on or after the target date. Question: What are the reason(s) you do not currently offer a target-date investment solution in your plan or removed the investment from your lineup? (Respondents could choose more than one reason.) Figure 1. Top four reasons plan sponsors don t offer TDFs (34% of plan sponsor respondents) Cost/complication of changing the plan lineup 42% Lack of good benchmarks for target-date investment solutions 38% Concerns about regulatory and legislative developments Need to provide participant population with individualized advice 0% 10% 20% 30% 40% 50% Percentage of plan sponsors without TDFs 3

4 2. Cost and performance are key Plan sponsors and consultants both cite cost and performance among the top three criteria in selecting a TDF. However, the two groups differ on priority. Plan sponsors offering TDFs rank cost first and performance third, while consultants rank performance as their most important criteria by a sizable margin. Cost is second. For plan sponsors, asset allocation/glide path design completes the top three criteria. rank active management approach third. Another distinction between the groups is the relative importance of the top three criteria. Plan sponsors rank their top three criteria within a tight range. Among consultants, there is significant dispersion among the ranking of their top three criteria, with 64% of consultants naming performance as first or second in importance, 34% reporting cost, and 17% citing active management approach as first and second mentions. Question: Please identify the three most important criteria in your selection of target-date investment solutions for your plan/clients. Figure 2. Most important selection criteria Cost Asset allocation/glide path design Performance Transparency Reputation of investment manager Passive (index-based) approach Underlying asset classes Private label opportunity Active management approach Customization/flexibility 13% 11% 9% 6% 6% 6% 38% 40% 49% 0% 10% 20% 30% 40% 50% 60% 70% 1st mention 2nd mention Percentage of plan sponsors with TDFs Performance Cost Active management approach Asset allocation/glide path design Customization/flexibility Transparency Reputation of investment manager Private label opportunity Underlying asset classes Passive (index-based) approach 5% 7% 8% 17% 14% 12% 34% 64% 0% 10% 20% 30% 40% 50% 60% 70% 1st mention 2nd mention Percentage of consultants 4

5 3. Overall favorable attitudes toward TDFs The survey asked plan sponsors and consultants to think about how their attitudes may have changed toward popular DC plan investment options between 2008 and TDFs emerge from this challenging three-year period with favorable views from both plan sponsors and consultants. In fact, plan sponsors report more favorable attitudes toward TDFs relative to other popular DC plan investment options, including static 60/40 balanced funds (more favorable is defined as those choosing a four or five on a scale of one to five). This holds true among plan sponsors who offer TDFs, as well as plan sponsors who do not. report generally favorable attitudinal shifts for most investment types, with the most favorable shifts toward stable value, TDFs, and active equity. Among all respondents, money market funds show the least favorable attitudinal shift in the last three years (least favorable is defined as those who chose a one or two on a scale of one to five). This is likely due to historically low yields and broad concerns about money markets breaking the buck, as the Reserve Primary Fund did in September Question: On a 5-point scale with 1=Less favorable and 5=More favorable, over the last three years, to what extent has your attitude, as a plan sponsor, changed toward the following investments? Figure 3. Attitude changes toward investments plan sponsors with TDFs Percentage of plan sponsors with TDFs 100% 75% 50% 0% 60% 34% 13% 9% Balanced funds 2% 8% 7% 6% 4% 9% 9% 21% 30% 24% 47% TDFs 53% 2% 4% Stable value 42% 32% 11% Money market 53% 55% 2% 7% 30% 23% 51% 55% 11% 8% 13% 2% 4% 2% 2% Active equity Passive equity Active fixed income Passive fixed income Investment options 5=More favorable =Less favorable 5

6 Question: On a 5-point scale with 1=Less favorable and 5=More favorable, over the last three years, to what extent has your attitude, as a plan sponsor, changed toward the following investments? Figure 4. Attitude changes toward investments plan sponsors without TDFs 100% 4% 4% Percentage of plan sponsors without TDFs 75% 50% 0% 21% 58% 21% Balanced funds 54% 29% 54% 17% 17% TDFs Stable value 38% 29% 42% 42% 12% 8% 4% Money market Active equity 50% 46% Passive equity 38% 38% 37% 37% Active fixed income Passive fixed income Investment options 5=More favorable =Less favorable Question: On a 5-point scale with 1=Less favorable and 5=More favorable, over the last three years, to what extent has your attitude changed toward the following investments? Figure 5. Attitude changes toward investments consultants 100% 12% 17% 19% 7% 7% 8% 7% 23% Percentage of consultants 75% 50% 34% 37% 37% 37% 31% 27% 31% 31% 47% 31% 39% 41% 32% 41% 39% 40% 0% 10% 14% 10% 12% 7% 2% 8% 3% 2% Balanced funds TDFs Stable value Money market Active equity Investment options 5=More favorable =Less favorable Passive equity Active fixed income 12% Passive fixed income 6

7 4. TDFs versus static balanced funds The survey also sought to compare TDFs with static 60/40 balanced funds in terms of a participant s complete retirement investment horizon. According to the survey, many plan sponsors with TDFs and consultants believe strongly that compared with a static 60/40 fund, TDFs simplify investment selection for participants, provide better asset allocation, and represent a better one-fund solution. Many also agree strongly that TDFs are a better default option and are easier for participants to understand during periods of market volatility. There are a number of consultants, as well as plan sponsors not offering TDFs, who believe TDFs are more risky and more complicated than a static 60/40 fund. Among plan sponsors who offer TDFs, 20% to share this view about the riskiness and complexity of TDFs. It s not surprising to see that, on a relative basis, plan sponsors who offer TDFs rank their features more favorably than plan sponsors who don t offer them. There is one notable exception: More plan sponsors who don t offer TDFs consider the funds easier for plan sponsors to evaluate when compared with their counterparts who offer the suite of funds and, therefore, must evaluate them. Question: On a 5-point scale with 1=Disagree strongly and 5=Agree strongly, to what extent do you agree with the following statements regarding target-date investment solutions over a typical participant s complete retirement investment horizon versus a 60/40 static balanced fund? Figure 6. TDFs versus balanced funds agree strongly Favorable statements Target-date options make selecting a plan investment easier for participants Target-date options provide better asset allocation Target-date options are a better one-fund solution for participants Target-date options are a better default option in a plan lineup Target-date options are easier for participants to understand during periods of high market volatility Target-date options are easier for plan sponsors to evaluate Unfavorable statements Target-date options are more complicated Target-date options are riskier 0% 10% 20% 30% 40% 50% 60% 70% Percentage of respondents agreeing strongly (4 or 5 on a scale of 1 to 5) Plan sponsors without TDFs 7

8 5. Appropriate use of TDFs The vast majority of all respondents (sponsors who offer TDFs, sponsors who don t offer TDFs, and consultants) consider TDFs an appropriate or highly appropriate investment for DC plan participants in general (appropriate and highly appropriate are defined as those responding with a three, four, or five on a scale of one to five). More than 90% of consultants and plan sponsors who offer the funds believe TDFs are appropriate or highly appropriate as a plan default option. Approximately eight of 10 plan sponsors who don t offer the funds share the same view. Among consultants and plan sponsors who don t offer TDFs, more than 8 of 10 also consider TDFs appropriate or highly appropriate for participants actively engaged in managing their investments. Sixty-four percent of plan sponsors who offer TDFs share this view. While these findings certainly represent the majority, we believe that a well-designed TDF with a reasonable expense ratio can be a suitable investment for all participants, including engaged, savvy investors. Question: On a 5-point scale with 1=Not appropriate and 5=Highly appropriate, to what extent do you believe that target-date investment solutions are appropriate for the following participants? Figure 7. For whom are TDFs appropriate? Plan participants in general Plan sponsors without TDFs Participants who are actively engaged in managing their DC investments Plan sponsors without TDFs Defaulted participants/as the plan qualified default investment alternative Plan sponsors without TDFs 0% 20% 40% 60% 80% 100% Percentage of respondents 1=Not appropriate =Highly appropriate 8

9 A vast majority (more than 90%) of all three groups consider TDFs appropriate or highly appropriate as part of a multifund solution for participant portfolios (appropriate and highly appropriate are defined as those who chose a three, four, or five on a scale of one to five). The results are less uniform for TDFs as a single-fund solution. While a majority of plan sponsors who offer the funds and consultants consider the funds appropriate or highly appropriate single-fund solutions (more than 70%), plan sponsors who don t offer the funds have more mixed views on the role of a TDF as a single-fund solution. Among this group, only 50% indicate that TDFs are appropriate or highly appropriate as a single-fund solution. Of course, TDFs were conceived as a single-fund solution, so we would expect that many respondents consider them appropriate as a participant s only investment. However, Vanguard research has shown that usage of the funds as part of a multifund portfolio is common (Pagliaro and Utkus, 2010) and enhances portfolio diversification (Utkus and Young, 2011). Many plan sponsors and consultants apparently recognize the inherent benefits of holding a mixed TDF portfolio one that combines a single TDF with another investment option(s). Question: On a 5-point scale with 1=Not appropriate and 5=Highly appropriate, to what extent do you believe that target-date investment solutions are appropriate as the following? Figure 8. The appropriateness of TDFs in a portfolio Part of multifund solution Plan sponsors without TDFs One-fund solution Plan sponsors without TDFs 0% 20% 40% 60% 80% 100% Percentage of respondents 1=Not appropriate =Highly appropriate 9

10 6. Equity allocations and to versus through While TDFs are well-regarded by the plan sponsor and consultant communities alike, opinions vary when it comes to equity allocations and glide path design around the target date and the landing point. We focus this discussion in two ways: 1) the appropriate level of equity at the target date (the year indicated in the fund name) and landing point (the final asset allocation); and 2) whether equity levels should change after the fund reaches its target date the to versus through debate. We define a through glide path as one with allocations that continue to change (and in most cases, decline) after the fund reaches its target date. The to glide path reaches its final asset allocation at or before the target date and does not change from the target date onward. The right equity allocation The survey finds sizable variation in views on appropriate equity allocation at the target date and the landing point. Still a vast majority of plan sponsors and consultants believe that TDFs should have some level of equity exposure at both the target date and the landing point. Only 2% of consultants and 0% of the plan sponsors in the survey believe that the funds should hold less than 10% equity as the funds arrive at their target date (see Figure 10). For the target date, most responses were in the 40%-to-79% range, with consultants favoring higher equity allocations than plan sponsors. Figure 9. Glide path design: to versus through Equity allocation 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Phase 1 Phase 2 Phase 3 Phase 4 Young Transition Retirement Late retirement To glide path Landing point to Landing point through Age Through glide path Target date (assumes age 65) Source: Vanguard. 10

11 Question: What do you believe is an appropriate equity allocation (percentage) for a target-date investment solution when it reaches the target date? (Open field) Figure 10. Equity allocation at target date 90% 100% 5% Equity allocation percentage 80% 89% 70% 79% 60% 69% 50% 59% 40% 49% 30% 39% 20% 29% 3% 4% 6% 7% 9% 11% 12% 12% 14% 17% 19% 20% 24% 30% 10% 19% 2% 4% 0% 9% 2% 11

12 Regarding the fund s landing point, responses cluster within the 20%-to-59% range, with consultants reporting generally higher equity allocations. The median for the target date among plan sponsors with TDFs is 50% equity. The median allocation drops to 40% once the glide path reaches its landing point. The median equity allocations at the target date and landing point for consultants are 52% and 50% respectively. The to versus through debate According to Figure 12, while a majority of plan sponsors with TDFs prefer a glide path that continues to change equity allocation after the target date or a through methodology 28% of plan sponsors who offer a TDF and of consultants prefer a to glide path design. The data in Figure 12 was derived from two different equity allocation responses (appropriate equity at the target date and appropriate equity at the landing point). Determining the appropriate equity allocations along the glide path is a debate that will likely continue since it is rooted in an individual s fundamental investment philosophy and objectives for the funds. Question: What do you believe is an appropriate equity allocation (percentage) for a target-date investment solution when it reaches the landing point? (Open field) Figure 11. Equity allocation at landing point 90% 100% 4% 8% 80% 89% 5% 6% Equity allocation percentage 70% 79% 60% 69% 50% 59% 40% 49% 30% 39% 2% 5% 7% 11% 12% 17% 17% 19% 24% 20% 29% 19% 10% 19% 3% 9% 0% 9% 2% 12

13 Figure 12. Difference in equity allocation between target date and landing point Increase more than 20% 6% 12% Increase 5% 20% 17% No change 28% To Decrease 5% 20% 32% Through Decrease more than 20% 19% 20% 0% 10% 20% 30% 40% Percentage of respondents 13

14 Conclusion Although investors have come through a volatile period, most plan sponsors and consultants report favorable attitudes and opinions about TDFs. Overall, favorable attitudes toward TDFs TDFs have become a mainstay in DC plans. The survey s findings are consistent with the continued adoption and broad usage of TDFs, in line with the favorable ratings for TDFs overall investment merits, concept/design, and ease of use among participants. The Pension Protection Act of 2006, which endorsed the funds as a QDIA, of course, continues to be a factor driving the adoption and the favorable views on the part of respondents. However, balanced funds and managed accounts, which are also designated as QDIAs under that legislation, have not been embraced by sponsors and investors to the same extent as TDFs. Some mixed views on riskiness, complexity While generally positive attitudes are reported, some respondents believe TDFs to be more risky and more complicated than a static 60/40 balanced fund. This belief is more prevalent among consultants and among plan sponsors who don t offer TDFs. This is a reasonable view since TDF glide paths, by design, reflect the changing asset allocation requirements of investors over the course of their careers and into retirement. This approach is a key benefit of TDFs and a challenge, making education and communication instrumental in clarifying the funds objectives, asset allocation, risks, and glide path for participants. It s incumbent on the industry to continue to enhance TDF education and communication efforts for participants, including both new investors as well as tenured investors in the funds. Ongoing portfolio construction debate While opinions about equity allocations at the target date and landing point vary, most respondents prefer moderate equity allocations at both points along the glide path. The survey also finds that most plan sponsors with TDFs and consultants embrace a through glide path design, while some believe that a fund s target date should be its asset allocation landing point. At the root of most portfolio construction decisions including TDF equity allocations is determining the appropriate risk/reward trade-off, a timeless and much-debated element of portfolio construction. 14

15 References Pagliaro, Cynthia A. and Stephen P. Utkus (2010), Mixed target-date investors in defined contribution plans, Vanguard. Utkus, Stephen P. and Jean A. Young (2011), How America Saves 2011, Vanguard. Appendix: Respondent demographics Our sample includes a total of 130 respondents. There are 71 plan sponsors (66% offering TDFs and 34% not offering them) and 59 consultants who participated in the survey, all of whom reported overseeing DC plans with at least $50 million in assets. Characteristics of our sample are summarized below. Respondent demographics Assets Plan ($ millions) sponsors 1, % 0% Number of participants 10, % 14% 5,000 9, ,000 4, Don t know 6 3 Investment committee Committee member 89% Nonmember 11 Role Senior management 77% Staff 23 Human resources 52% Treasury/Finance 41 Other 7 15

16 P.O. Box 2900 Valley Forge, PA Connect with Vanguard > institutional.vanguard.com For more information about Vanguard funds, visit institutional.vanguard.com or call to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing. All investing is subject to risk. Diversification does not ensure a profit or protect against a loss in a declining market The Vanguard Group, Inc. Vanguard Marketing Corporation, Distributor. All rights reserved. IAMTRFF